Cavium Should Be Bottoming Out
Networking chip specialist Cavium (Nasdaq:CAVM) may have started the year as one of the few growing semiconductor stocks, but eventually the tough chip market sucked this name into the whirlpool as well. Although many growth investors have bailed out on fears that rivals will gain shares, more patient, aggressive investors may want to consider this as a rebound name for 2012.
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A Tough Third Quarter
It doesn't matter that Cavium's year-on-year numbers were decent, as few chip investors pay any attention to that frame of reference. So while revenue did indeed rise almost 23% from last year, the fact that it dropped a little over 5%, sequentially, is the more relevant figure.
Cavium saw weakness in its core advanced network processor business, as sales fell 6% sequentially. Broadband sales were up 7%, but that's a much smaller business at this point. Overall, Cavium was wounded by its still-heavy reliance on Cisco (Nasdaq:CSCO) - one of Cisco's assemblers has changed its inventory system and Cisco sales were down 19% from the second quarter.
Although operating leverage usually crushes tech companies when revenue flags, Cavium did well in this regard. Gross margin was basically flat on a sequential basis, though down about two points from last year. Operating income jumped significantly, but largely just due to the absence of an earn-out liability in the second quarter. Absent that adjustment, operating income fell a bit from last year and about 15% sequentially.
Enterprise Is a Mixed Bag
At this point, investors may want to ask for the real enterprise market to please stand up. Some companies like IBM (NYSE:IBM), F5 (Nasdaq:FFIV) and EMC (NYSE:EMC) indicate it's not so bad, while others like Cisco (Nasdaq:CSCO) and Juniper (Nasdaq:JNPR) have a grimmer view. And, since the latter two are sizable customers (though F5 is a Cavium customer as well), their opinions are really the ones that matter right now.
The good news, such as it is, is that networking is not going away. Likewise, storage data centers are still building out, more wireless backhaul will be needed for 4G services, and streaming video is becoming a bigger market day by day ((helped by companies like Netflix (Nasdaq:NFLX) and Amazon (Nasdaq:AMZN)). Better still, this Cisco inventory adjustment process should work itself out in the fourth quarter, and that should remove some of the deadweight on Cavium's results.
How Long for the World?
Disappointing fourth quarter guidance does not really change anything, regarding Cavium's long-term outlook. The real question is whether or not Cavium wants to engage in the day-to-day battles to stay independent. To be sure, Cavium could go the route of Broadcom (Nasdaq:BRCM) and become a more diversified chip player. In the meantime, the company will have to fend off rivals like Broadcom, Tilera and Freescale (NYSE:FSL), the latter of which seems to be seeing good adoption for new multicore processors.
More likely is that Cavium will eventually get (and accept) a buyout proposal. Although a company like Intel (Nasdaq:INTC) could be interested, Qualcomm (Nasdaq:QCOM) seems like a better bet to me. It's not quite accurate to say that Qualcomm and Broadcom are in a tit-for-tat competition, but the reality is that the company's do overlap and compete, and Cavium would arguably be an even better deal for Qualcomm than NetLogic was for Broadcom.
The Bottom Line
Cavium's stock has not been especially strong, but that does not make the shares dirt-cheap. The stock could certainly do well if and when that 2012 recovery materializes (or rather, the market's faith in that recovery materializes). After all, valuation rarely matters with tech growth stories so long as the market believes in that growth.
Investors more concerned with price and value could well look at other names like F5, Riverbed (Nasdaq:RVBD), Juniper or even Cisco in lieu of Cavium. More aggressive investors, though, should not underestimate the chance that this company can maintain 20%+ annual growth for a while yet, and attract a better multiple once investors have more faith in the tenor of the Cisco business.
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.